The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that CSP Inc. (NASDAQ:CSPI) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can’t easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is CSP’s Net Debt?

The image below, which you can click on for greater detail, shows that CSP had debt of US$3.36m at the end of June 2021, a reduction from US$5.71m over a year. But it also has US$19.7m in cash to offset that, meaning it has US$16.3m net cash.

How Strong Is CSP’s Balance Sheet?

According to the last reported balance sheet, CSP had liabilities of US$16.4m due within 12 months, and liabilities of US$13.5m due beyond 12 months. On the other hand, it had cash of US$19.7m and US$19.2m worth of receivables due within a year. So it can boast US$8.96m more liquid assets than total liabilities.

It’s good to see that CSP has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don’t think it will have any issues with its lenders. Simply put, the fact that CSP has more cash than debt is arguably a good indication that it can manage its debt safely. There’s no doubt that we learn most about debt from the balance sheet. But it is CSP’s earnings that will influence how the balance sheet holds up in the future.

Over 12 months, CSP made a loss at the EBIT level, and saw its revenue drop to US$53m, which is a fall of 23%. That makes us nervous, to say the least.

So How Risky Is CSP?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year CSP had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$133k and booked a US$83k accounting loss. While this does make the company a bit risky, it’s important to remember it has net cash of US$16.3m. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn’t produce free cash flow regularly.